Did you know that on average, a surgical sponge is retained in one out of every 8000 surgeries here in the U.S? That amounts to 4000 incidents per year, or 11 per day. In addition to having to remove the retained sponges and treat the infections that occur there are usually legal expenses as well. It is estimated that a retained sponge costs a hospital ~$415,000.00. In total, this costs U.S. hospitals ~$1.7 billion per year. If you work it out on a per surgery basis: $415,000.00/8000= $51.88 per surgery.
To date, Patient Safety Technologies (OTCQB:PSTX) and their SurgiCount Safety-Sponge System have:
- Over 75 million sponges accounted for.
- Over 3.6 million procedures performed.
- 264 hospitals have signed up to implement the system. 171 were implemented as of 4/27/12 and the majority of the remaining 93 will be implemented by July 2012.
- 7 of the 17 U.S. News & World Report Best Hospitals Honor Roll Users are using the SurgiCount System. No competitor has more than 2.
- They have never lost a customer.
If you need further validation of the system, the Mayo Clinic performed an independent clinical study between February 2009 and June 2010. The results were published in February 2011, and they were very positive. No retained sponges and the personnel got used to the SurgiCount method quickly. The Mayo Clinic now uses the SurgiCount system in all of their hospitals.
World Class Customer List
What are the economic benefits?
The SurgiCount sponges only cost ~$13-$15 more to use in each surgery vs. traditional surgical sponges, so the economic benefit here is obvious. Hospitals can spend an extra $13-$15 per surgery and:
- Avoid tremendous amounts of trouble and a public black eye for the hospital.
- Avoid health complications for the patient.
- Avoid the long-range costs of $51.88 per surgery, which is ~3-4x what it would cost to simply use the SurgiCount System.
PSTX currently faces very little competition. Their competitors have been around for a while, have yet to gain traction, are more expensive to implement, and they don't appear to be sufficiently capitalized to compete.
Patient Safety Technologies has an exclusive distribution agreement with Cardinal Health (CAH). As per the agreement, Cardinal Health must keep 60 days of inventory on hand at any given time, so as the number of hospitals implemented grows, that number becomes larger. PSTX agreed to $10 million in inventory to Cardinal Health up front in 2009. To this point Cardinal Health has held on to this inventory and agreed not to release it into the market. As their marketing partner, Cardinal Health has a vested interest in seeing PSTX succeed. Thus, they are very unlikely to release this inventory when it can very adversely impact PSTX.
The domestic market opportunity for the SurgiCount System are the 5600 acute care hospitals in the US. The company estimates the addressable market opportunity in the U.S. alone is ~$450 million annually ($80,000 per hospital x 5600).
In November 2011, PSTX signed an agreement with Premier Healthcare Alliance, which will allows PSTX to market to over 2500 hospitals and over 78,000 healthcare sites. This agreement provides access to over 40% of the U.S. acute care hospital addressable market and is expected to bear fruit in the second half of 2012.
There are 4 large IDN's (Integrated Delivery Networks) here in the U.S.
- Community Health Systems Inc (CYH)
- Tenet Healthcare Corp (THC)
- Hospital Corporation of America (the biggest)
- Kaiser Permanente
In September 2011, PSTX landed their first large IDN with Community Health Systems . It was initially estimated to be 130 hospitals but that number has since increased to 145-150. Closing additional IDN's will substantially increase revenues and profitability. For example, 5% of the entire hospital population is in an HCA hospital at any given moment. Considering HCA only operates 163 hospitals, this potential IDN win would drive revenue per hospital up substantially.
Market Penetration Increasing at a Greater Rate
In March 2012, the company announced an increase of implementations.
93 hospitals are currently in the implementation process and the majority of those should be completed by July 2012 increasing the installed base to 264 hospitals. This would be an increase of 340% since April 2011.
The beauty of the business model is that they give away the SurgiCount System scanners and then depreciate them. The only thing the hospital purchases are the sponges and this is how PSTX makes their money. This is basically a razor-razor blade model where PSTX gives away the razor.
PSTX currently has visibility on 264 hospitals. My current expectation is that they will have visibility on 350 hospitals by the end of 2012. I think 500-600 by the end of 2013 is also a fairly reasonable expectation given their current traction in the marketplace. It is my belief that as more hospitals are implemented, market adoption will increase.
I created a financial model and feel pretty comfortable with my numbers up to 2000 hospitals. Here are some assumptions I've used in building the financial model:
- These are only annual run rates. It is virtually impossible to guess exactly what their numbers will be for each fiscal year because you don't know how many hospitals they will add. We also have the Cardinal overhang (which I tend to believe they will push out as long as possible).
- They ended Q4 2011with 98 hospitals implemented and revenues were $2.7 million, so I will use 94 as the average for the quarter. That puts revenue per hospital for the quarter at $28,700 ($115,000 annualized). CEO Brian Stewart mentioned that they were at $130,000 per hospital at the Roth Conference in March 2012. Based on my talks with management I feel that $80,000 is a pretty conservative per hospital measure going forward on an annualized basis.
- Gross margins for the most recent quarter were 42%. The company has guided for 50%. When you add back in the non-cash depreciation for scanners in Q4 you get back to 50%. I have used non-GAAP numbers here and thus I feel 48% is perfectly feasible.
- At 300 hospitals I have estimated that annual OPEX will be ~$9.5 million or $2.375 million per quarter. This is likely high but I'd rather be conservative. Management has indicated that they can implement 25 hospitals per quarter with OPEX at $1.7 million. 50 per quarter with OPEX at $2.1 million. Therefore I believe these OPEX numbers are perfectly reasonable expectations.
- They have enough cash to get to the current 264 hospitals. At that point they should be cash flow positive. Regardless, I think they will have to do a secondary financing in the next 12-24 months and my model assumes that they pay back the Series A.
- It is also hard to come up with a fully diluted share count for each run rate as we don't know what the share price will be and thus when exactly they will do a secondary. I have assumed that it will do well and thus most options and warrants currently outstanding will be exercised.
- I have attempted to estimate the fiscal years and hospital installed bases. PSTX is at 264 hospitals right now. With ~8 months to go in 2012 I think it is pretty safe to say that they will enter 2013 with at least 300 hospitals. I believe it is possible that in the next 12-18 months we are looking at 500-600 hospitals committed to implementation.
Disclosure: The author, MicroCapClub Contributor Ryan Parker, is long PSTX